Description

The term financial intermediary may refer to an institution, firm or individual who performs intermediation between two or more parties in a financial context. Typically the first party is a provider of a product or service and the second party is a consumer or customer. It may be a specialist financial institution, which collect funds from savers and lend to corporate and other borrowers, that is, savers (lenders) give funds to an intermediary institution (such as banks), and then that institution in turn gives those funds to spenders (borrowers). This may be in the form of loans or mortgages. Alternatively, they may lend the money directly via the financial markets.

Why are financial intermediaries important?

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As the main source of external funding, banks play important roles in corporate governance, especially during periods of firm distress and bankruptcy. The idea that banks “monitor” firms is one of the central explanations for the role of bank loans in corporate finance. Unlike bonds, bank loans tend not to be dispersed across many investors. This facilitates intervention and renegotiation f capital structures. Bankers are often on company boards of directors. Banks are also important in producing liquidity by, for example, backing commercial paper with loan commitments or standby letters of credit.

By bank-like financial intermediaries, we mean firms with the following characteristics:
1. They borrow from one group of agents and lend to another group of agents.
2. The borrowing and lending groups are large, suggesting diversification on each side of the balance sheet.
3. The claims issued to borrowers and to lenders have different state contingent payoffs.

The terms “borrow” and “lend” mean that the contracts involved are debt contracts. So, to be more specific, financial intermediaries lend to large numbers of consumers and firms using debt contracts and they borrow from large numbers of agents using debt contracts as well. A significant portion of the borrowing on the liability side is in the form of demand deposits, securities that have the important property of being a medium of exchange. The goal of intermediation theory is to explain why these financial intermediaries exist, that is, why there are firms with the above characteristics.

Most people do not enter financial markets directly but use intermediaries or middlemen. Commercial banks are the financial intermediary we meet most often in macroeconomics, but mutual funds, pension funds, credit unions, savings and loan associations, and to some extent insurance companies are also important financial intermediaries.
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